# PEG Ratio

> The PEG ratio divides P/E by expected earnings growth to compare growth stocks. Learn the formula, how to interpret it, worked examples and its important limits.

Source: https://learn.tradelabsai.com/fundamentals/peg-ratio/  
Track: Fundamental Analysis · Level: Intermediate · Updated: 2026-10-03  
Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice.  
Cite as: TradeLabs Learn, "PEG Ratio", https://learn.tradelabsai.com/fundamentals/peg-ratio/

A high P/E can be justified if a company is growing fast. The PEG ratio tries to capture that trade off in one number by dividing the P/E ratio by the expected earnings growth rate. Popularised by investor Peter Lynch in his 1989 book "One Up on Wall Street", the PEG ratio is a quick way to compare companies with different growth rates. It is useful as a screening tool, but it relies heavily on growth forecasts and ignores risk and the length of growth.

## The formula

```
PEG = P/E ratio / expected annual EPS growth rate (in percent)
```

Growth is entered as a whole number: 20% growth becomes 20.

## Interpreting PEG

| PEG | Common interpretation |
|---|---|
| Below 1 | Possibly undervalued relative to growth |
| Around 1 | Fairly valued relative to growth (Lynch's rule of thumb) |
| Above 1 | Possibly expensive relative to growth |
| Above 2 | Expensive unless growth is very durable or low risk |

These thresholds are rules of thumb, not laws.

## Worked example

**Example: Comparing two growth stocks**
| | Company A | Company B |
|---|---|---|
| Price | $120 | $60 |
| Forward EPS | $3.00 | $2.00 |
| Forward P/E | 40 | 30 |
| Expected EPS growth (next 3 to 5 years) | 30% a year | 10% a year |
| PEG | 40 / 30 ≈ 1.33 | 30 / 10 = 3.0 |

Company A has a higher P/E but a lower PEG, so it may be cheaper relative to its growth. But if Company A's growth slows to 15%, its PEG jumps to about 2.7. The ratio is only as good as the growth estimate.

## Variations

- **Trailing vs forward:** use forward P/E with forward growth to match time periods.
- **PEGY ratio:** P/E divided by (growth + dividend yield), crediting dividend paying companies for income.
- **Different growth horizons:** analysts typically use 3 to 5 year expected EPS growth.

## Limits of the PEG ratio

1. **Growth estimates are uncertain.** Analysts' long term growth forecasts have historically been too optimistic on average, according to academic studies of analyst forecasts.
2. **Duration of growth is ignored.** A company growing 20% for 2 years is worth far less than one growing 20% for 10 years, yet both have the same PEG.
3. **Risk is ignored.** A riskier company deserves a lower multiple at the same growth.
4. **Quality of growth:** growth from acquisitions or buybacks differs from organic growth.
5. **Low or negative growth** makes the ratio meaningless or extreme.
6. **Interest rates:** the "fair" PEG changes as rates change.

## PEG in practice

- **Screening:** find growth companies that do not look overpriced relative to expectations.
- **Comparisons within an industry,** where risk and growth duration are similar. See [Comparable Companies and Precedent Transactions](https://learn.tradelabsai.com/fundamentals/comparable-companies/).
- **Sanity checks:** a PEG of 4 or 5 should prompt questions about what the market is assuming.

For more rigorous analysis, a discounted cash flow model makes growth duration and risk explicit. See [DCF Valuation](https://learn.tradelabsai.com/fundamentals/dcf-valuation/).

## Common mistakes

- **Using one year growth** for a multi year valuation.
- **Comparing PEGs across very different industries.**
- **Trusting long term analyst growth estimates** without checking their realism.

## Checking the growth input

Before trusting a PEG, compare the growth estimate with the company's own history, its industry's growth and its guidance. If a company grew earnings 8% a year for a decade but the PEG uses 25% future growth, ask what has changed. Revenue growth, margin trends and reinvestment rates should all support the forecast. See [Guidance and Earnings Revisions](https://learn.tradelabsai.com/fundamentals/guidance-and-earnings-revisions/).

## Frequently asked questions

### What is the PEG ratio?

The P/E ratio divided by the expected annual earnings growth rate, used to compare valuation relative to growth.

### What is a good PEG ratio?

A PEG around 1 is often considered fair and below 1 potentially cheap, but these are rules of thumb that depend on risk and the reliability of growth estimates.

### What are the weaknesses of the PEG ratio?

It depends on uncertain growth forecasts, ignores how long growth lasts and ignores differences in risk.

Next, learn multiples that account for debt in [EV/EBITDA and EV/Sales](https://learn.tradelabsai.com/fundamentals/ev-ebitda-and-ev-sales/).

## Continue learning

- Next lesson: [EV/EBITDA and EV/Sales](https://learn.tradelabsai.com/fundamentals/ev-ebitda-and-ev-sales/)
- Previous lesson: [P/E and Forward P/E](https://learn.tradelabsai.com/fundamentals/p-e-and-forward-p-e/)
- Related: [P/E and Forward P/E](https://learn.tradelabsai.com/fundamentals/p-e-and-forward-p-e/): The P/E ratio compares a stock's price with its earnings. Learn trailing vs forward P/E, earnings yield, what high or low P/E means and the ratio's limits.
- Related: [Valuation Basics](https://learn.tradelabsai.com/fundamentals/valuation-basics/): Valuation estimates what a business is worth. Learn intrinsic vs relative valuation, the main multiples, how growth and risk affect value and common mistakes.
- Related: [Comparable Companies and Precedent Transactions](https://learn.tradelabsai.com/fundamentals/comparable-companies/): Comparable company analysis values a business using the multiples of similar companies. Learn how to pick peers, build a comps table and adjust for differences.
- Related: [Growth and Dividend Factors](https://learn.tradelabsai.com/research/growth-and-dividend-factors/): Growth, investment and dividend factors look at how firms grow, invest and pay shareholders. Learn the evidence, including why aggressive investors lag.
- Related: [Guidance and Earnings Revisions](https://learn.tradelabsai.com/fundamentals/guidance-and-earnings-revisions/): Company guidance and analyst estimate revisions shape expectations. Learn how guidance works, why revisions predict returns and how traders track them.